Analyze "Currency Hedging" and describe how currency hedging is used in global financing operations

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Risk is the uncertainty that you may not earn your expected return on your investments.

Exchange Rate Risk
Organization which invest internationally in today's increasingly global investment arena face the prospect of uncertainty in the returns after they convert the foreign gains back to their own currency. Unlike the past when most U.S. investors ignored international investing alternatives, investors today must recognize and understand exchange rate risk, which can be defined as the variability in returns on securities caused by currency fluctuations. Exchange rate risk is sometimes called currency risk.

Types of exposure

Transaction exposure
It is the extent to which given exchanges rate change will change the value of foreign currency denominated transactions already entered into.

Translation (Accounting) exposure
The change in the value of a firm's foreign currency denominated accounts due to a change in exchange rates.

Economic exposure
It measures how greatly a firm's present value of future cash flows is affected by unexpected exchange rate fluctuations.

Comparison
Transaction exposure arises whenever a company is committed to a foreign-currency-denominated transaction. Since the transaction will result in a future foreign currency cash inflow or outflow, any change in the exchange rate between the time the transaction is entered into and the time it is settled in cash will lead to a change in the dollar (Home Currency) amount of the cash inflow or outflow.

Transaction exposure is a subset of economic exposure. It is because the currency fluctuations affect more than currency transactions. For example an increase in inflation in USA may:
1. Lower value of outflow from US (transaction exposure)
2. Increase subsidiary's US sales
3. Raise financing cost in US

Thus domestic firm has also foreign exchange risk according to the economic exposure. For example, when the value of the dollar falls or weakens in relation to another currency, prices of goods and services from that country rise for U.S. consumers. It takes more dollars to purchase the same amount of foreign currency to buy goods and services. That means U.S. consumers and ...